Tips For Trading Gold

Before discussing any possible tips for trading gold, it can prove useful to review the forces that actually impact the price of gold. Then, we can explore how to best take advantage of its ups and downs.

Gold is similar to a currency, and in fact has acted as a medium of exchange in many countries since ancient times, because it is widely accepted, durable, uniform and portable. However, in the modern world, it is considered a commodity much like oil, crops, and other metals like silver and copper. This is mainly because gold is not supported by an underlying economy and not minted by a country or a central bank, like an actual currency.

Because it is not minted by any country, gold is seen by its advocates as a hedge against what's happening in other financial markets, which can be moved by political developments, inflation, interest rates and manipulation by governments. Gold therefore offers diversification from other asset markets.

Indeed, gold is generally seen as a "safe haven" asset to which investors flock in order to protect themselves in times of:

financial stress, or

economic or political turmoil, such as hyperinflation, wars, natural and manmade disasters, and the like.

Conversely, when times are relatively quiet and economies are growing, gold tends to lose its luster and prices start to fall.

With regards to inflation, adherents see gold as being able to retain its value even as currencies can lose theirs.

Ways To Trade Gold

Now that we know what affects the price of gold in both directions, what's the best way to trade it? There are several ways.

Some investors prefer to take physical possession of gold to ensure that they can access it at will, but that can be prohibitively expensive, as there are costs to transport, store, protect and trade it. As a result, physical gold is difficult to sell quickly.

But there are other ways to trade gold, or a reasonable proxy for it, without the cost and hassle of taking physical possession of it. Investors can opt to make trades electronically from their desk just as they would with other financial assets.

Gold Futures Contracts

The most common way to trade gold is through a futures contract, which is an agreement to buy or sell something at a future date without actually having to take possession of the physical commodity. Gold futures contracts are traded every day on exchanges operated by the Chicago Mercantile Exchange (CME). There is a standard gold future (GC) that represents 100 troy ounces of gold, and a micro gold future (MGC), which represents 10 troy ounces.[1]

But some investors find futures overly complex and confusing. Trading futures can also be prohibitively expensive, with initial margin requirements on a single 100-ounce contract in excess of US$10,000. Trading gold can also be risky, especially in times of financial turmoil, making trading in futures contracts not for everybody.

Gold ETFs

Fortunately, there are some good proxies for gold futures that require substantially less money up front with significantly lower risk. For example, there are many exchange-traded funds (ETFs) that are tied to the gold market, either backed by physical gold, portfolios of futures and options, or linked to gold and mining stocks. Gold ETFs trade just like those of any common stock or other ETF.
Some ETFs closely track the price movements of gold, while others are leveraged to magnify price changes by two or three times. Conversely, some ETFs are structured to move in the opposite direction of the price of the metal ("inverse" funds), enabling bearish investors to essentially short the price of gold and profit if the price of the metal falls.
The two largest and most actively traded gold ETFs—and the two that most closely track gold price movements—are:

SPDR Gold Trust (GLD). Backed by holdings of physical gold, this is the largest gold ETF. Shares are priced at roughly 10% of the price of an ounce of gold. The ETF also has actively traded options offering different strike prices and expiration dates.

iShares Gold Trust (IAU). IAU is a grantor trust that's also backed by holdings of physical gold. Shares are valued at roughly 1% of gold's current market price.
Thus, if you wanted to hold a position equivalent to an ounce of gold, you would buy 10 shares of GLD or 100 shares of IAU.[2]

Mining Company Shares

Another way to play the gold market is by buying shares in companies that mine gold, such as Goldcorp (GG), Newmont Mining (NEM) and Barrick Gold (ABX). But there are disadvantages to this route.

First of all, shares of mining companies are just that, shares in a company, not a direct proxy for gold. While shares of these companies often move up and down with the price of gold, they are also affected by other factors, such as trends in the overall equity market, which is what holding gold is intended to protect you against.[3]

Use Technical Charts

Gold acts as a hedge against the movements in other asset markets, including currencies, stocks and bonds, and against inflation. These factors make it useful for investors to research technical charts tracking the price of gold going back a number of years to see how it has reacted during specific periods. They can then potentially anticipate how the metal is likely to react if similar events were to repeat themselves.

For example, if the price of gold fell after a central bank raised interest rates in order to fight inflation, one may believe that the price would again fall if the bank intervened in the market. Similarly, if the price of gold tends to rise during a stock market correction, one may predict that it will fall during a bull market, and vice versa.
At least initially, investors new to trading gold should keep their positions in the metal fairly small until they get more comfortable and confident about what moves the market.

Summary

Gold can act as a hedge against events in other markets and inflation and is often seen as a "safe haven" from turmoil. While it's possible to invest in gold by buying the metal directly, it can be prohibitively expensive and quite involved. However, there are several reasonable proxies, including gold futures, gold ETFs, and mining stocks.

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